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Business Watch: December 24, 2002


24 December 2002, Volume 2, Number 40
ENERGY
DISABLED KALMYK TRADERS REDUCED SIBNEFT TAX BURDEN
An audit by the Russian Accounting Chamber has shown that loopholes in tax legislation and canny hiring practices allowed oil major Sibneft to reduce its 2001 tax burden by 10 billion rubles ($314 million), RosBusinessConsulting (RBK) reported on 17 December. According to a report that appeared in "Vedomosti" on 18 December, Sibneft used two legal stratagems to minimize its taxes. Sibneft-Noyabrskneftegaz, which accounts for 98.4 percent of Sibneft's crude production, sold all of its oil to trading firms in Chukotka and Kalmykia, where local and regional tax breaks reduced rates from 35 percent to 24 percent. The company was able to cut the remaining 11 percent tax in half by employing disabled traders. Disability-related tax breaks ended on 1 January 2002. Tax havens continue to function in Chukotka and Kalmykia. According to RBK, the Accounting Chamber intends to submit the results of the audit, which merely identifies mechanisms used to reduce the company's tax burden and makes no accusations of untoward conduct, to President Vladimir Putin for review with an eye to closing remaining loopholes in tax legislation. DK

AGREEMENT REACHED ON ADRIATIC PIPELINE
The governments of Belarus, Croatia, Hungary, Russia, Slovakia, and Ukraine signed a 10-year accord on 16 December to integrate the Druzhba and Adria oil-pipeline networks, "Kommersant" reported on 17 December. The integrated pipeline will transport Russian oil to the Croatian deep-water port of Omisalj, easing access to world markets. Initial transport volume will be 5 million tons of oil per year with a transport tariff of $0.64 per ton per 100 kilometers. Transport volume will eventually increase to 15 million tons annually. Yukos and Tyumen Oil Company (TNK) are the obvious beneficiaries of the accord, as each has agreed to supply 2.5 million tons of oil annually. State-owned oil company Rosneft signed a letter of intent with Texas-based Marathon Oil to ship Russian oil to North America through Omisalj, "Vedomosti" reported on 17 December, raising the question of quotas in conditions of limited initial volume. TNK spokesman Vladimir Bobylev told "Finansovye izvestiya" on 17 December, "The project allows us to organize a new outlet for Russian oil...and makes it possible to take aim at the American market." DK

FINANCE
SUPREME COURT DECISION RAISES GHOSTS OF AUGUST 1998
In a decision that touched on one of the more problematic aspects of Russia's August 1998 financial crisis, the Supreme Court ruled that forward contracts are subject to legal defense, "Kommersant" reported on 17 December. Societe Generale Vostok took its case to the Supreme Court in an attempt to recover debts from Russian banks Rossiiskii Kredit, Avtobank, and Alfa-Bank. The three banks still owe Societe Generale Vostok for hard-currency forward contracts that went unpaid after financial crisis gripped Russia in August 1998. The contracts provided for the future sale of hard currency at a rate of approximately 6 rubles to the dollar (the rate before the ruble crashed on 17 August 1998), rendering their satisfaction a dismal proposition for Russian banks after the ruble subsequently lost some two-thirds of its value. According to "Kommersant," Russian banks owed approximately $9 billion on forward contracts in the aftermath of the 1998 crisis. Until this recent decision, the issue was academic, as Russian law treated forward contracts as equivalent to a wager and thus not subject to legal defense in court. Opinions differed on the Supreme Court decision, however. "Kommersant" opined that it "created the danger of an avalanche of reviews of existing agreements on forward contracts" that could spark a banking crisis. "Vedomosti" noted on 18 December, however, that while the court decision opens the door to numerous lawsuits, it does not revoke the article in the Civil Code that equates forward contracts with wagers. The newspaper concluded that no matter how many suits are filed, "we already know the result -- judges will just have more paperwork to deal with." DK

MOODY'S RAISES RUSSIA RATING
Ratings agency Moody's Investors Service raised Russia's rating on 17 December from Ba3 to Ba2, still two notches below investment grade, "Vedomosti" reported on 18 December. The move, which puts Russia on a par with such developing countries as Colombia, Belize, India, and Fiji, frustrated those who had hoped for a quicker path to the sought-after investment grade that will make Russia more attractive to conservative investors. "This might disappoint some in the market who were gunning for a two-notch upgrade," Bear Stearns strategist Tim Ash was quoted as saying by "The Moscow Times" of 18 December. Standard & Poor's upped Russia's rating in early December to BB, also two notches below investment grade, with a "stable" outlook; but is unlikely to review the country's standing in the near future because of upcoming parliamentary and presidential elections. DK

COMPANIES
ILIM PULP DISPUTE HEATS UP AGAIN
Aluminum tycoon Oleg Deripaska's ongoing attempt to wrest control of the Kotlas pulp and paper mill from Ilim Pulp entered a new phase on 18 December when pro-Deripaska management tried unsuccessfully to enter the mill and establish control, "The Moscow Times" reported on 19 December. The conflict over the mill began in May, when Deripaska's Basic Element, acting in conjunction with St. Petersburg banker Vladimir Kogan, gained control of a 61 percent stake in the Kotlas mill, Russia's largest, through a controversial court decision that was later overturned. Nevertheless, forces affiliated with Deripaska who still claim to control 61 percent of the mill's shares conducted their own extraordinary shareholders' meeting on 13 December to elect a rival board of directors, "Kommersant" reported on 16 December. Their subsequent attempt to enter the mill was foiled by Ilim Pulp security, which has maintained physical control of the facility throughout the conflict. With recent court decisions firmly on its side, Ilim Pulp seems poised to rebuff this latest challenge. Lesprom Industry analyst Anna Kurbatova told "Vedomosti" on 16 December, "Ilim Pulp has sufficient resources to protest the [shareholders'] meeting and prevent its opponents from gaining control of the mill." DK

GAZ HALTS PRODUCTION, LOOKS TO BAGHDAD FOR RELIEF
With slack domestic demand for its cars forcing assembly-line shutdowns, Russia's second-largest passenger-car producer is hoping that a new order from Iraq kick starts flagging sales. The Gorky Auto Factory (GAZ) will neither confirm nor deny that it will halt production of its flagship Volga sedan until February, "Vedomosti" reported on 17 December. Dealers told the newspaper on condition of anonymity that the company is simply not turning a profit on Volgas, once the standard means of conveyance for the Soviet elite. With three production stoppages this year already, GAZ will produce fewer than 70,000 Volgas instead of the planned 98,000. But an Iraqi order for 5,000 Volga cabs could get the conveyer belt up and running again, "The Moscow Times" reported on 19 December. When queried about the possible effect of military action in Iraq on the contract, which could be worth more than $25 million, GAZ spokesman Vasilii Sarychev told "The Moscow Times," "If we thought like that, we wouldn't be able to do business at all." Russian automakers will likely bid 2002 farewell with a feeling of good riddance, as low demand and overproduction afflicted the nation's top two carmakers. Russian carmakers' market share slipped from 71 percent in 2001 to 63 percent in 2002, "Vremya novostei" reported on 16 December. DK

ZELENOGRAD COMPUTER FACTORY CHANGES HANDS...AGAIN
The battle for control of the Kvant computer factory in Zelenograd tipped in favor of AFK Sistema, which ousted representatives of rival IVK and installed its own management team on 12 December, "Vedomosti" reported on 17 December. The two companies are locked in a conflict over the factory, with each claiming to hold a controlling stake. When the factory last changed hands in August, IVK seized the facility with the help of soldiers and armed guards, "Kommersant" reported on 18 December. Kvant is the largest personal-computer assembly facility in Russia. AFK Sistema regained control of the factory on 12 December with an order from a St. Petersburg court to collect a 50,000 ($1,570) debt and the by-now-familiar armed-security detail, "Izvestiya" reported on 17 December. AFK Sistema now plans to integrate the factory into a single production cycle to manufacture Sitronics brand computers. Vladimir Chepko, IVK's deposed general director, said that he plans to turn to law enforcement authorities for help in resolving the conflict. DK

INVESTMENT
CANADIANS GO FOR THE GOLD IN CHUKOTKA
Canada's Bema Gold mining company has signed an agreement with the government of Chukotka, led by oil tycoon Roman Abramovich, to acquire up to a 75 percent interest in the Kupol gold and silver property, the company announced in a 18 December press release. Under the terms of the agreement, Bema Gold will pay $30.5 million over two years for a 40 percent interest in Kupol, expending an additional $10 million on exploration. The acquisition of the final 35 percent will be contingent on a feasibility study. Russian estimates put the Kupol site's gold reserves at 835,000 ounces and silver at 9.4 million ounces, "The Moscow Times" reported on 19 December. Renaissance Capital metals analyst Rob Edwards described the price of the deal to "The Moscow Times" as "very fair," adding, "Bema has been one of the stories the precious metals industry needs in order to give people hope that you can do business here successfully." The press service of the Chukotka government states that Governor Abramovich intends to keep looking for investors, with the Maiskoe gold field next on the agenda, "Vedomosti" reported on 19 December. DK

RUSH TO RETAIL
The aptly named Mega Mall, with 120,000 square meters of retail space and a food court capable of seating 3,000 people, opened in Moscow on 12 December, "The Moscow Times" reported on 17 December. Mega Mall features such powerhouse retailers as Sweden's IKEA, France's Auchan, and Germany's OBI, not to mention a U.S. joint-venture, 11-screen multiplex set to open next summer. The $200 million complex showcases increasing Western attention to Russia's expanding, if still Moscow-centric, retail sector. France's do-it-yourself retailer Leroy Merlin is also looking to get in on the action with two stores in Russia, "Vedomosti" reported on 17 December. A part of the Auchan Group, Leroy Merlin plans to expand in tandem with Auchan. Igor Sosin, co-owner of DIY Project Russia, told "Vedomosti" that with 70 percent of home products still bought at markets, the retail sector has plenty of expanding to do before real competition begins: "We'll have to open dozens of DIY hypermarkets for us [OBI and Leroy Merlin] to compete directly with each other." Maksim Karbasnikov, associate director of corporate real-estate firm Jones Lang Lasalle, estimates that Moscow has room for 70 hypermarkets, "Le Monde" reported on 16 December. The capital currently has 10. DK

SWISS MANUFACTURER TO INVEST $350 MILLION IN KOSTROMA FACILITY
Switzerland's Krono Group will invest $350 million over the next five years in a production facility to make fiberboard, furniture parts, and office furniture in the Kostroma region, "Kommersant" reported on 17 December. The company officially opened its Kronostar factory in Sharya on 16 December, "Vedomosti" reported on 17 December. Kronotec, Krono Group's management company, has already invested $40 million into the Kronostar facility, which will reach its full production capacity of 150,000 cubic meters per year of fiberboard in March. According to "Vedomosti," Krono Group hopes to become the largest producer of fiberboard on the Russian market. Under the agreement Kronotec reached with Kostroma's regional administration, the firm will be exempted from regional taxes for six years. A 17 December editorial in "Vedomosti" noted that the deal demonstrates the effectiveness of offering regional tax credits to draw investments. In a 2 December interview with "Izvestiya," Kronotec Vice President Viktor Vaitsel explained that market conditions will determine whether the factory's products will be sold in Russia, abroad, or both. DK

COMMUNICATIONS
VIMPELCOM TAKES ON KALININGRAD
Vimpelcom advanced its regional-expansion program with the acquisition of a 100 percent stake in leading Kaliningrad cellular operator Extel, the company announced in a 17 December press release. Vimpelcom paid $25 million for Extel, buying up 51 percent of its shares from private hands and a 49 percent stake from a subsidiary of Norway's Telenor, which itself holds a 25 percent stake in Vimpelcom, "The Moscow Times" reported on 18 December. According to the Vimpelcom press release, Extel has 105,000 subscribers, some 65 percent of the Kaliningrad market. ACM Consulting analyst Anton Pogrebinskii told "Vedomosti" on 18 December that Vimpelcom paid only $238 per new subscriber, a figure he termed "quite low," perhaps because of competition from other major operators already active in the region. Troika Dialog analyst Tom Adshead told "Izvestiya" on 18 December that Kaliningrad's status as Russia's "western outpost" should ensure substantial roaming revenues.

AROUND THE CIS
GAZPROM STRIKES UZBEKISTAN DEAL
Gazprom representatives signed a cooperation agreement on 18 December with Uzbekistan's national oil and gas company Uzbekneftegaz, Interfax reported. The agreement covers shipments of Uzbek gas for the period 2003-12, with Gazprom to purchase 10 billion cubic meters of gas from Uzbekistan annually by 2005. A contract between Gazexport, Gazprom's export arm, and Uztransgaz to purchase 5 billion cubic meters of gas in 2003 was also signed. DK

LUKOIL SELLS STAKE IN AZERBAIJAN PROJECT TO JAPANESE
LUKoil sold its 10 percent stake in the Azeri-Chirag-Guneshli (ACG) project to Japan's Inpex for $1.375 billion, Interfax reported on 20 December. LUKoil President Vagit Alekperov stated that the company's decision to pull out of the project is part of a general restructuring in which LUKoil will review its participation in projects where it does not have operator status. U.S.-British company Ramco Energy sold its 2.0825 percent stake in the project in 2000 to Saudi Arabia's Delta Hess for $150, representing less than $75 million for each percent, while LUKoil received $137.5 million for each percent, gazeta.ru calculated on 20 December. For the deal to go through as planned in the first half of 2003, it must obtain the approval of Azerbaijan State Oil Company (SOCAR) and all of the ACG consortium participants. DK

IN FOCUS
SLAVNEFT: ARE THE FORMATIVE YEARS OVER?
Vladimir Korovkin, president of the Russian Federal Property Fund's Federal Stock Corporation and official auctioneer at the state's 18 December sale of its 74.95 percent stake in oil company Slavneft, had simple instructions for the participants: no cell phones, no smoking, and no foul language. By these admittedly limited standards, the subsequent auction appears to have been a runaway success.

Three minutes of tepid bidding nudged the starting price of $1.7 billion to $1.86 billion and produced a winner. Invest-Oil, a firm created by oil majors Sibneft and Tyumen Oil Company (TNK) especially for the auction, placed the winning bid, and at 12 o'clock noon Sibneft President Yevgenii Shvidler stepped forward to receive a symbolic bouquet of flowers for his company's part in the privatization of Russia.

Slavneft extracts 320,000 barrels of oil a day from its proven reserves of 2.54 billion barrels, "The Wall Street Journal" reported on 19 December, making it Russia's ninth-largest oil producer. Its privatization, which some analysts predicted could add up to $3 billion to the state's coffers, was big news in the way that big money always makes big news. For a brief moment, eyes turned to Russian capitalism to take stock and render judgment.

They were not disappointed for lack of spectacle. The months leading up to the 18 December auction showcased a series of masterful maneuvers, combining business and politics to culminate in a foregone conclusion. Sibneft, controlled by oil tycoon and Chukotka Governor Roman Abramovich, succeeded in: 1) installing a former Sibneft executive as the CEO of Slavneft; 2) demonstrating that it can influence the earnings of Slavneft subsidiaries to transform preferred shares into voting shares, thereby readying a "poison pill" for any potential buyer; 3) acquiring an 11 percent stake in Slavneft from Belarus to further complicate matters for other prospective suitors. In a final spate of intrigue, China National Petroleum Corporation made a stab at participating in the Slavneft auction before bowing out in a firestorm of political controversy, and a string of suspicious last-minute court decisions struck four names from the list of bidders.

Western reaction to the sale was largely negative. Irregularities "raised a swirl of questions about Russia's commitment to fairness and transparency," the "Chicago Tribune" wrote on 19 December. The auction "gave new meaning to the word opaque," "The New York Times" opined the same day. A 20 December editorial in "The Moscow Times" simply stated that "it all went wrong," adding that the Russian government "has shot itself spectacularly in the foot and blown all the rhetoric about establishing a level playing field clean out of the water." Only "The Wall Street Journal" issued a preliminary "two cheers" on 18 December, concluding, "Russia may not have perfected its privatization process yet; but the bar has definitely been raised."

Russian commentary was more resigned. "Kommersant" referred to a "four-minute imitation of open bidding" on 19 December. "Vedomosti" fretted in an editorial the same day that the last-minute exclusion of four companies from the list of bidders "damaged the image of the Russian privatization process in the eyes of investors, primarily foreign investors." Remarks by prominent politicians to gazeta.ru on 18 December focused mainly on the selling price, which many felt should have been higher.

In point of fact, the Slavneft auction, with its convoluted preamble to a predictable conclusion, presented less of a "test case" for the Putin administration's commitment to fairness and openness than a snapshot of business as usual in a particular system of economic and political relations. In the four years since the financial meltdown of 1998 -- years that saw the orderly transfer of power to a new president in conditions of relative macroeconomic well-being -- that system has moved from the reform- and crisis-induced upheaval of a dysfunctional, kleptomaniacal childhood to an increasingly confident adolescence. Even as it lurches toward maturity, the teenager boasts some telltale traits: oil-fueled, politically connected, hip to the letter of the law, and more than willing to do what it takes to get what it wants.

As with any teen, the key question is whether this is just a passing phase or the close of the hopeful, troubled, formative years and the beginning of settled, warts-and-all adulthood. DK

IN FOCUS
GAS LEAK
Is Gazprom, one of the Russian budget's biggest sources of cash and a vital supplier of natural gas to Western Europe, on the verge of bankruptcy? A 17 December article in "Nezavisimaya gazeta," replete with the publication of confidential internal documents from Gazprom, breathlessly relates that "the debt noose is tightening around Gazprom's throat...judging by the numbers, bankruptcy is relentlessly approaching."

The numbers are hardly reassuring. Gazprom owes $14.7 billion. Payments on that debt in 2003 will total $7.5 billion. The document obtained and published by "Nezavisimaya gazeta," blandly titled "On approving the program of borrowing and issuing securities in 2003," reveals that "approximately 70 percent of total export revenue, including 97 percent of revenue on contracts with first-class European partners, is tied up in active credit obligations." The document notes that "in terms of Gazprom's ability to service it, the current level of indebtedness is nearing the maximum allowable level."

The article in "Nezavisimaya gazeta," the first in a three-part series of articles detailing mismanagement and bungling at Gazprom, echoed from the capital to the provinces. Moscow's "Komsomolskaya pravda" asked on 19 December "Where is Gazprom Headed?" and described Gazprom's debt woes in dire terms drawn directly from "Nezavisimaya gazeta" (without attribution). Krasnoyarsk's "Segodnyashnyaya gazeta" and Rostov-na-Donu's "Molot" reprinted the gist of the "Nezavisimaya article" on 18 December and 20 December, respectively, both under the headline "Gazprom on Verge of Bankruptcy." Even foreigners took note. Germany's "Die Welt" discussed the publication in some detail on 18 December, nervously adding that "Gazprom is Germany's most important supplier of natural gas."

Gazprom denied the bankruptcy charge. Natalya Selivanova, press secretary to Gazprom CEO Aleksei Miller, told RIA "Novosti" on 17 December that "Gazprom remains a dependable borrower with an unblemished reputation in the international financial community." She did not dispute the authenticity of the confidential material published by "Nezavisimaya gazeta," claiming instead that "there is nothing sensational about the document." Selivanova did, however, remark that "revealing Gazprom's negotiating positions with foreign financial institutions, as reflected in the borrowing program, undoubtedly harms the company." She ended by stating that the two-tiered pricing system that keeps domestic prices for gas unnaturally low "affects the company's financial situation. Gazprom feels that gas rates within Russia should be raised."

Why did this document surface when it did? An 18 December article in "Vedomosti" suggests one possible explanation. The article details Gazprom's plans to reduce its debt in 2003 from $14.7 billion to $10-$11 billion. The analysts quoted by "Vedomosti" are largely skeptical, although no one seems to see bankruptcy looming on the horizon. Noting that Gazprom dearly hopes that the government will agree to a domestic rate hike of more than 20 percent, Alfa-Bank analyst Sergei Glazer comments that "It's no accident that a final decision on rates...was postponed until the first quarter of 2003."

An 11 December cabinet meeting came out in favor of a 20 percent increase in domestic rates for natural gas instead of the 37 percent Gazprom had hoped for. The 17 December publication of a confidential Gazprom document in "Nezavisimaya gazeta" cast doubts on the company's financial health and resonated as far as the international press. In its response, Gazprom rejected any suggestion of impending bankruptcy, yet stressed the need for higher gas rates within Russia. One begins to wonder how exactly "Nezavisimaya gazeta" obtained the document in question...

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